Why social impact bonds could be one way to counter current low yields

Social impact bonds could be one answer for investors struggling in the current low interest rate regime. That’s the view of one expert: Arnold Packer, former US Assistant Secretary of Labor during the Carter administration.

In a letter published in the Financial Times, directed at former PIMCO chief Bill Gross, Packer recommends he “show imagination with negative-yield bonds”. Gross had expressed concerns to the FT of continuing the current low interest rate regime indefinitely, referring to $13trn of negative-yielding bonds.

In response, Packer urges Gross, who is now portfolio manager of the Janus Capital Group Global Unconstrained Bond fund strategy, to consider social impact bonds.

“It can only be a colossal lack of imagination that keeps a substantial portion of those fallow funds from attending to the world’s deficit in investments in human capital (as well as physical infrastructure),” he writes.

He describes social impact bonds as a way to get higher yields while mitigating some of the ills that threaten political stability in the developed and developing world.

Social impact bonds are where private investors fund the delivery of a social intervention, such as increasing educational attainment for teenagers, in the hope of a financial return if measured outcomes are met.

They are in their infancy but growing. A recent report from Social Finance, creator of the world’s first social impact bond, finds globally there have been 60 social impact bonds raising $216m in capital across 15 countries, including Australia where its first social impact bond (SIB), or social benefit bond – the term commonly used in the country – is showing early signs of strong success which may help to bolster Packer’s case.

The SIB in question, which seeks to prevent children from being placed in foster care, is in operation in Australia’s New South Wales (NSW). The NSW government pays investors a return if successful outcomes are met in the seven-year SIB.

Speaking last year to RI, NSW Treasurer Andrew Constance said the SIBs were developed in response to the social challenges facing NSW and described them as an innovative vehicle to deliver better outcomes for its communities.

The SIB, dubbed the Newpin bond after the programme it uses (New Parent and Infant Network) has had stellar results so far — financially and socially. There has been a cumulative restoration rate of 61% for children supported by the programme that is currently three years in operation. It paid investors a 7.5% return in its first year, 8.9% in its second and this year, its third, will pay a return to investors of 12.15%.Elyse Sainty, director, impact investing at Social Ventures Australia (SVA), who is involved in the Newpin bond, says it is still “early days”.

Sainty says the NSW government has been “delighted” with the programme and attributes some of its success to using an initiative that had an established track record.

She also said a clear link to government savings from the social impact bond has made things easier at the structuring stage. “It’s a lot of money for a child to be cared for by the state, if they are successfully restored to their family there is a clear link to government savings.

“It’s a clear straightforward metric. Are they restored to family and how long did they stay with a control group built to compare.”

One stated benefit of social impact bonds is that in effectively tackling social problems, such as lowering chronic reoffending, it saves government departments – and taxpayers – money (part of which can be used to pay back investors).

The Newpin bond has around 60 investors – a relatively high number in a single SIB – including high net worth individuals, family trusts and Australian superannuation funds. In a comment on its website NGS Super, the super fund for education and community-focused organisations, which invested A$500,000 in the SIB, outlines it reasons for investing. It says it presents a “viable and sound financial outlook” and it aligned closely with its environmental, social and ethical investment framework, which its members greatly value.

Commenting on its third year results, Anthony Rodwell-Ball, CEO at NGS Super, said: “This is an exceptional milestone for Newpin and even more rewarding for our members because of the positive social and financial returns it has delivered.” Sainty says the Newpin bond has been structured so that the most investors will lose is 50% of their money. During the first three years – there was protection of 75% and there was an early termination clause for poor performance for year three.

Other SIBs around the world have a similar structure, with some form of protection built in for investors. This method is said to be necessary to attract investors, especially institutional ones, to quite a new investment product.

But some in the SIB field disagree, saying the design undermines market discipline and is artificial. Some SIBs offer no protection and investors risk losing all their money if it fails, but can benefit from high returns if outcomes are successfully met.

There are currently three SIBs in New South Wales – the Newpin bond, another SIB also supporting children back into their homes, and a recently announced SIB looking to tackle recidivism. Sainty says another three are in the works; SVA is involved in two.

Four of Australia’s six states are developing SIBs – NSW, Victoria, Queensland and South Australia.Australia’s federal government has said it will amend legislation to boost investment in social impact bonds and prepare a discussion paper on impact investing following a sweeping inquiry into the country’s financial system.

As long as the current low interest rate environment persists, it seems, SIBs will continue to be a great source of social benefit, portfolio diversity – and return.